HMRC commissioned a telephone survey of almost two thousand VAT registered businesses representing 17 different industry sectors. The aim was to explore their knowledge and use of VAT partial exemption and to gain information on rates of VAT recovery in those industrial sectors. The survey was carried out in 2016 and the findings were included in a report published on the UK government website in January 2018.

VAT incurred on goods and services used to make exempt supplies cannot be recovered and where a business makes both taxable and exempt supplies it is referred to a partially exempt. These businesses need to calculate the proportion of their VAT on general overheads that can be recovered and there are different methods that can be used to calculate the input tax recovery. The standard method, applicable to most businesses, is based on the value of supplies made by the business. A business can also apply to HMRC to use a special method.

The research found that awareness of VAT partial exemption was high but detailed knowledge of the process was more limited. Of the businesses that could not recover all their input tax 86% reported that they had heard of partial exemption but 12% had not. Around 14% of the businesses claimed to have extensive knowledge of partial exemption and 32% knew a fair amount. Of the businesses that were aware of partial exemption 51% knew a fair amount about how to calculate it and 32% knew about different partial exemption methods. Information was gained from agents or from HMRC.

Larger businesses were generally more knowledgeable about partial exemption and were more likely to be using a partial exemption method. Knowledge varied by industry sector, due to differences in the use of partial exemption, with businesses in financial services, education or activities auxiliary to finance generally most knowledgeable. Businesses in postal courier services, retail and construction were the least knowledgeable and were least likely to be using a partial exemption method.

Of the businesses surveyed 24% were using the standard method and 13% were using a special method. Use of a partial exemption method was most common in financial services and in social work without accommodation; and least common in postal and courier services, retail and construction. The most common partial exemption methods were based on a single overhead or a “pot” and there was a mixture of different calculations. Methods were used because they were most appropriate for the particular business sector. The highest levels of VAT recovery were in retail and public administration while the lowest were in education and in social work without accommodation.

Around 29% of the businesses that were aware of VAT partial exemption generally reviewed their calculation method on an annual basis, while another 29% never reviewed their partial exemption method. The rest of the businesses reviewed the calculation at different intervals or on an ad hoc basis. Of the businesses that had used partial exemption 68% reported that they had incurred compliance costs, most commonly in relation to staff time and accountant fees, especially where a special method was used.